Janice Lozano
Students who are investing may need to pay taxes on their stock profits, also known as capital gains. In the US, the Internal Revenue Service (IRS) imposes a 'kiddie tax' on the unearned income of minors and full-time students up to the age of 24. If a student's investment income is over a certain threshold, their parents may be subject to an additional tax bill. However, there are ways to avoid these levies, such as investing in tax-advantaged accounts or holding investments long-term in taxable accounts. While short-term capital gains taxes can range from 0% to 37%, long-term capital gains taxes are generally lower, ranging from 0% to 20%.
| Characteristics | Values |
|---|---|
| Who has to pay the tax? | Parents of dependent children under 18 or under 24 if they're full-time students |
| What is taxed? | Capital gains, dividends and interest |
| What is the threshold for taxation? | $2,200 in profit according to CNBC; $2,600 in unearned income according to IRS and H&R Block; $2,700 in unearned income according to Charles Schwab |
| What forms need to be filled out? | Form 8615, Form 8814, Form 1040, Form 1040-SR, Form 1040-NR, Form 1099-B |
| How to avoid the tax? | Invest in an individual retirement account or stick with tax-friendly assets |
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Kiddie tax
The "kiddie tax" is a tax imposed on income unrelated to employment earned by individuals aged 18 or younger, or dependent full-time students under the age of 24. The tax was introduced as part of the Tax Reform Act of 1986 to prevent parents from registering investments in their children's names to benefit from lower tax rates.
The kiddie tax threshold is adjusted annually for inflation. For the 2023 tax year, unearned income under $1,250 qualifies for the standard deduction. The next $1,250 is taxed at the child's rate, which can sometimes be 0%. Any income above this threshold is taxed at the parent's marginal income tax rate.
The Internal Revenue Service (IRS) provides guidelines on how to report a child's unearned income. If a child's unearned income exceeds $2,600, Form 8615 must be attached to the child's tax return. The child must also meet one of the following age requirements: under 18 at the end of the tax year, 18 at the end of the tax year with no earned income exceeding half of their support, or a full-time student aged 19 to 24 at the end of the tax year with no earned income exceeding half of their support.
Parents may avoid kiddie tax levies if their children invest in an individual retirement account or choose tax-friendly assets. Additionally, exchange-traded funds may be more tax-efficient than assets with dividends or capital gains payouts.
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Capital gains tax
It is important to note that capital gains taxes do not apply to unrealized capital gains or unsold investments. In the context of stocks, this means that stock shares will not incur taxes until they are sold, regardless of how long they are held or how much their value increases. Additionally, capital gains taxes do not apply to investments held in tax-advantaged accounts, such as 401(k)s, Individual Retirement Accounts (IRAs), 529 college savings plans, and Health Savings Accounts (HSAs). These accounts allow investments to grow tax-free or tax-deferred, with taxes typically incurred only upon withdrawal.
For students, the "kiddie tax" comes into play. This applies to children under the age of 18 or under the age of 24 if they are full-time students and still dependents on their parents' tax returns. The "kiddie tax" is an additional levy for parents once their child's investment income, including capital gains, dividends, and interest, exceeds a certain threshold. If a student's income is above a certain threshold, they may be required to file a tax return using Form 8615, which calculates the tax on unearned income. However, if the student's income is below the threshold, their parents can attach Form 8814 to their tax return, allowing the child to avoid filing a tax return.
To minimize capital gains tax liability, individuals can offset capital gains with capital losses. If losses exceed gains, the excess loss can be deducted from income to reduce future tax liability. Additionally, holding assets for longer than a year can qualify for the lower long-term capital gains tax rate. Consulting a tax advisor or using a tax calculator can help navigate the complexities of capital gains taxes and identify strategies to minimize tax obligations.
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Tax-free accounts
If you are a student with stocks, you may be subject to capital gains tax. Capital gains tax is a tax on the profit made from selling a capital asset, such as stocks, for more than you bought it. However, there are certain tax-free accounts that you can use to save for education or retirement that may help you lower your tax burden.
Coverdell IRAs
Coverdell IRAs are education savings accounts that allow you to put up to $2,000 each year into any investment vehicle you choose. The money can be used for educational expenses at any level, including primary, secondary, and tertiary education. While contributions are not tax-deductible, distributions from these accounts are tax-free as long as they are made at least five years after the account was created.
Roth IRAs
Roth IRAs are typically used for retirement savings, but they can also be used to pay for education expenses. The annual contribution limit is $5,500 ($6,500 for people aged 50 or over). Like Coverdell IRAs, contributions are not tax-deductible, but distributions are tax-free as long as the account is at least five years old.
529 Plans
529 Plans are education savings plans offered by most states that allow you to save for K-12 and post-secondary education costs. State tax deductibility and maximum contribution limits vary depending on the plan. The money can be used for educational expenses at any level.
Flexible Spending Accounts (FSAs) and Health Savings Accounts (HSAs)
FSAs and HSAs can provide tax relief while helping with healthcare and, in some cases, childcare expenses. You can contribute to these accounts before paying income tax on your earnings, making your dollars go further.
It's important to note that the tax laws and regulations may vary depending on your location and individual circumstances. Therefore, it is always recommended to consult with a tax professional or accountant for specific advice.
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Form 8615
Students may have to pay taxes on stocks if their income exceeds a certain threshold. This is known as the "kiddie tax," an extra levy for parents once their child's investment income—capital gains, dividends, and interest—exceeds a certain threshold. The "kiddie tax" was introduced by the IRS to combat the practice of higher-income parents moving assets to their children's accounts to pay lower taxes on earnings.
For tax year 2024, the first $1,300 of a child's unearned income is tax-free. The next $1,300 is taxed at the child's income tax rate for that year. Any unearned income above $2,600 is taxed at the marginal tax rate of the parent(s), which is usually higher than the child's rate. This tax treatment is commonly referred to as the "kiddie tax."
It is important to note that the rules and thresholds for Form 8615 may change over time, and it is always recommended to consult with a tax professional for specific advice.
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Tax on unearned income
Students who are under the age of 18 or full-time students between the ages of 19 and 24 with unearned income exceeding a certain threshold are required to pay taxes on their unearned income. This is known as the "kiddie tax" and is a levy on the investment income of children, including capital gains, dividends, and interest.
Unearned income refers to income that is derived passively, without performing work or providing a service. It is often acquired through investments, such as interest on savings, dividends from stocks, rental income from properties, or capital gains. It also includes other sources such as inheritance money, gifts, alimony payments, and rental payments.
The tax rates on unearned income differ from those on earned income, which includes wages, salaries, and business activities. For example, short-term capital gains taxes range from 0% to 37%, while long-term capital gains taxes range from 0% to 20%. High-income earners may also be subject to an additional 3.8% net investment income tax on short- and long-term capital gains.
In the United States, students falling under the "kiddie tax" requirements must fill out Form 8615, "Tax for Certain Children Who Have Unearned Income". This form is used to calculate the child's tax on unearned income, which is then taxed at the parent's rate. Any gains exceeding a certain threshold, typically around $2,500 to $2,600, will be taxed at the parent's marginal tax rate.
It is important to note that there are ways to avoid or reduce the "kiddie tax". For example, students can invest in individual retirement accounts or tax-friendly assets, such as exchange-traded funds, which may be more tax-efficient than assets with dividends or capital gains payouts. Seeking advice from a tax professional or accountant is recommended to understand the specific tax obligations and strategies for a given situation.
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Frequently asked questions
Students are subject to what is known as the "kiddie tax". This means that if a student's investment income exceeds a certain threshold, their parents will be charged a levy at their tax rate.
The threshold for the "kiddie tax" is $2,200 in profit. The first $1,350 of unearned income is not taxed. The next $1,350 is taxed at the child's marginal tax rate. Anything above $2,700 is taxed at the parents' marginal tax rate.
Unearned income includes capital gains distributions, dividends, and interest income.
Form 1099-B, Form 8615, Form 8814, Form 1040, Form 1040-SR, and Form 1040-NR are all forms that may need to be filled out depending on the situation.
Yes, students may avoid the "kiddie tax" by investing in an individual retirement account or sticking with tax-friendly assets.
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